Currency getting too hot to handle

The record strength of the Australian dollar has arguably got the better of the domestic sharemarket, which has snapped a four-month winning streak.

The S&P/ASX 200 index fell 0.3 per cent during April, and the 1.02 per cent slide on Friday pushed the measure into the red on the final trading day of the month.

Although the index showed signs of breaking the 5000 barrier for the first time in a year, many investors have noted the remarkable rise of the Australian dollar is a burgeoning headwind for the Australian economy and a weight on the sharemarket.

The Australian dollar is up 5.5 per cent during April for its best month since December and broke through $US1.09 for the first time as a floated currency.

Boosting the Australian dollar was the US Federal Reserve’s reiteration on Thursday morning Australian time that it would keep interest rates at very low levels.

The continued ultra-loose monetary policy has encouraged investors to buy high-yielding assets such as equities, commodities and currencies such as the Australian dollar.

Also putting the US dollar under pressure was ratings agency Standard & Poor’s decision in late April to downgrade its outlook on US sovereign debt to negative.

Gold, the traditional haven investment, reached a record $US1540.85 on April 29.

Related Quotes

Company Profile

April has been when numerous global central banks came into focus, with Europe raising the cash rate for the first time since the financial crisis and China lifting rates for the fourth time since October.

Even domestically, economists now think there is a chance the Reserve Bank of Australia could raise interest rates sooner than previously thought, following stronger than expected March quarter inflation data.

The Australian sharemarket is trading on a forward price/earnings (PE) ratio of almost 14 times, which is in line with historical averages. UBS equity strategist David Cassidy says the market is not looking “particularly expensive", but the high dollar and possible cash rate move will be the headwinds in May and any pull back will be a function of this. April is historically the best month for Australian shares, according to AMP Capital Investors, with an average return of about 2.4 per cent from 1980. May and June have historically been weak months.

Investors are nervous about the psychology of consumers, according to JPMorgan equity strategist Paul Brunker.

“Our view was that the interest rate markets had gone a little bit too complacent about the risk of RBA hikes and they have adjusted to some degree," he said

“We do think there are more tightenings to come this year and the next, and what that does for equities is keep them in a range, because until we know where that process ends it’s difficult to see the equities re-rating because the risk is that they end up tightening too much and earnings take another hit."

With the dour mood, defensive sectors such as healthcare, insurance, utilities and the banks performed better than did the broader market.

Yield is shaping up as a key component in decision-making, and the big four banks are among the positive movers during April. Banks are also relatively protected from US dollar concerns and are an alternative for US exposed stocks.

Expectations of reasonably solid results in May are often a reason for banks rallying into reporting season. But Mr Cassidy warns that domestic focused stocks, such as the banks, could run into cash rate issues down the line.

Industrial stocks have borne the brunt of the high Australian dollar, weak consumer spending and a lack of appetite for credit.

Valuations are not cheap for the sector, and although they are now fair, they are trending towards the more expensive side, according to Perpetual portfolio manager Matt Williams.

Commodity prices are also falling in Australian terms, which could put resource stocks under pressure in May.

Copper, which shot to record highs in April, has retreated to $8,563 a tonne, pricing last seen in November. Gold is down almost 2 per cent from its March high, but when measured in US dollar terms is up 9.4 per cent on the same period. The West Texas Index oil price, which is causing global consternation as Middle East and North African political turmoil continues to jepoardise supplies, reached $US113.37 on 8 April. Since then, pricing has eased 0.5 per cent when measured in US dollars, but more than 4 per cent when measured against the Australian dollar.

Aside from commodity concerns, companies and investors are still wary after Japan’s natural and nuclear disasters in March.

Uranium plays remained subdued but liquid natural gas companies were the net beneficiaries of chatter about the need to diversify energy resources after the Fukushima disaster.

Woodside has been a strong performer, also helped by speculation
BHP Billiton
could be making a bid for the LNG producer. Shares in BHP, meanwhile, matched its May 2008 record high of $49.55 and it is now one of the world’s five biggest companies.

Renewable energy provider Infigen Energy posted a 29.75 per cent return for the month, placing it second in line on the best performer rankings to Equinox Minerals. Roc Oil, followed with returns around 16 per cent.

Chinese data for the March quarter is positive on the growth target, with industrial production 15 per cent higher, electricity generation up and crude steel consumption beating analyst forecasts.

The figures indicate a better than expected outlook for the industrial giant, and should allow the market to take a breather from nagging concerns about the impact of tightening economic policy, says RBS’s Daniel Blake.

Mr Cassidy sees real strength in Sonic Healthcare and Primary Health Care, both of whom reaped rewards from the government boost to funding for the pathology industry.

CSL and Cochlear, while not showing spectacular results have been “slight outperformers". This is surprising, says Mr Cassidy, given company earnings are domiciled in the US, so there may be some scope for pull back coming in to May.

The so-called confession season also picks up in May and into June and there have already been signs of it. The high Australian dollar is tipped to be a major driver of downgrades.

“This may help to explain why the market has been reluctant to make more progress than it otherwise would," Mr Brunker said. “One concern is that there are some profit warnings lurking out there from currency, commodity costs, or just from a soft economy."

Goodman Fielder
was the most recent company to downgrade earnings when, on Thursday, it shaved 20 per cent from its forecast yearly profit.

Equinox Minerals
and
Computershare
created interest during the week. Equinox’s board recommended a bid from Canada’s Barrick Gold, and the share registry company bought the share owner services business of Bank of New York Mellon.

Talk has eased about whether the index will break 5000 points and market watchers seem unperturbed by the prospect arising in the June quarter.

“It’s not a particularly demanding level – the index can be at 5000 points and still not be stretched from a valuation perspective," Mr Cassidy said.JP Morgan has set a June target of 4750 but thinks the stronger US economy may drag stocks through the 5000 point level, and Mr Blake forecasts a market at 5250 by the end of June.